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Exam 12: Estimating Cash Flows on Capital Budgeting Projects

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Question 51

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You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $100 initially, and then $150 per year in maintenance costs. Machine B costs $200 initially, has a life of three years, and requires $120 in annual maintenance costs. Either machine must be replaced at the end of its life with an equivalent machine. Which is the better machine for the firm? The discount rate is 12% and the tax rate is zero.

A) Machine A
B) Machine B
C) Both Machines A and B
D) Neither Machine A nor B

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Question 52

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As new capital budgeting projects arise, we must estimate

A) the float costs for financing the project.
B) when such projects will require cash flows.
C) the cost of the loan for the specific project.
D) the cost of the stock being sold for the specific project.

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Question 53

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You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $50,000. The truck falls into the MACRS three-year class, and it will be sold after three years for $20,000. Use of the truck will require an increase in NWC (spare parts inventory) of $2,500. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 40 percent. What will the free cash flows for this project be?

Which of the following statements is correct with respect to Section 179 deductions?

You are evaluating two different machines. Machine A costs $10,000, has a five-year life, and has an annual OCF (after tax) of -$2,500 per year. Machine B costs $15,000, has a seven-year life, and has an annual OCF (after tax) of -$2,000 per year. If your discount rate is 14 percent, using EAC which machine would you choose?

Your firm needs a machine which costs $100,000, and requires $25,000 in maintenance for each year of its 3-year life. After 3 years, this machine will be replaced. The machine falls into the MACRS 3-year class life category. Assume a tax rate of 35% and a discount rate of 14%. What is the depreciation tax shield for this project in year 3?

You are trying to pick the least-expensive machine for your company. You have two choices: machine A, which will cost $100,000 to purchase and which will have OCF of -$7,000 annually throughout the machine's expected life of three years; and machine B, which will cost $125,000 to purchase and which will have OCF of -$2,600 annually throughout that machine's four-year life. Both machines will be worthless at the end of their life. If you intend to replace whichever type of machine you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 15 percent, which one should you choose?

KADS, Inc. has spent $400,000 on research to develop a new computer game. The firm is planning to spend $50,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000. The machine has an expected life of 3 years, a $10,000 estimated resale value, and falls under the MACRS 5-Year class life. Revenue from the new game is expected to be $500,000 per year, with costs of $200,000 per year. The firm has a tax rate of 35 percent, an opportunity cost of capital of 15 percent, and it expects net working capital to increase by $25,000 at the beginning of the project. What will the year 3 free cash flow for this project be?

Your firm needs a machine which costs $125,000, and requires $5,000 in maintenance for each year of its 3-year life. After 3 years, this machine will be replaced. The machine falls into the MACRS 3-year class life category. Assume a tax rate of 35% and a discount rate of 10%. If this machine can be sold for $15,000 at the end of year 3, what is the after-tax salvage value?

This is used as a measure of the total amount of available cash flow from a project.

Equipment was purchased for $50,000 plus $2,500 in freight charges. Installation costs were $1,500 and sales tax totaled $1,000. Hiring a special consultant to provide advice during the selection of the equipment cost $3,000. What is this asset's depreciable basis?

Give an example of each of the following: (a) Opportunity cost, (b) Substitutionary effect, (c) Complementary effect and (d) Sunk cost.

When calculating operating cash flow for a project, one would calculate it as being mathematically equal to which of the following?

With regard to depreciation, the time value of money concept tells us that

Which of the following statements is correct?

You are evaluating a project for your company. You estimate the sales price to be $50 per unit and sales volume to be 5,000 units in year 1; 10,000 units in year 2; and 2500 units in year 3. The project has a three-year life. Variable costs amount to $10 per unit and fixed costs are $75,000 per year. The project requires an initial investment of $25,000 in assets which will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $5,000. NWC requirements at the beginning of each year will be approximately 20 percent of the projected sales during the coming year. The tax rate is 34 percent and the required return on the project is 13 percent. What change in NWC occurs at the end of year 1?

Section 179 allows a business, with certain restrictions, to do which of the following?

Your company is considering a project that will cost $100. The project will generate after-tax cash flows of $37.50 per year for five years. The WACC is 10% and the firm's D/A ratio is .70. The flotation cost for equity is 6%, the flotation cost for debt is 3%, and your firm does not plan on issuing any preferred stock within its capital structure. If your firm follows the practice of incorporating flotation costs into the project's initial investment, what is the firm's flotation-adjusted cash flow in year 0?

An asset's cost plus the amounts you paid for items such as sales tax, freight charges, and installation and testing fees is referred to as the ___________________.

One way to account for flotation costs of raising capital is to